School Loans: Debt-to-Income Ratio

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Matt Soladay

Matt Soladay

Congratulations!  You have finished your formal training, and if you haven’t already, you just have to pass your board exam.  Well, that, and…pay off your school loans.

Most of us borrowed money to earn our degree or finish training.  But school loan debt might not truly sink in until you have to make that first payment, which can certainly cause some stress. Having a plan of action of how you will eliminate your debt over time will help mitigate the financial burden you may be feeling.

The most important thing to consider when looking at how much you owe in school loans, is to compare it to how much your job pays.  This comparison is called the Debt-to-Income Ratio. 

Calculate Your Debt-To-Income Ratio

The following three examples will show you how to calculate your debt-to-income ratio to help you better understand your student loan situation.

Example 1:  You owe $35,000 in school loans, and you make $70,000. 
     Debt:Income Ratio: 35,000/70,000= 0.5 
     In this example, you owe half of what you earn. 

Example 2:  You owe $70,000 in school loans, and you make $70,000.
     Debt:Income Ratio: 70,000/70,000= 1.0
     In this example, you owe the same amount of money that you earn.

Example 3:  You owe $140,000 from your degree, and you make $70,000. 
     Debt:Income Ratio: 140,000/70,000= 2.0
     In this example, you owe twice what you earn.

Understanding your ratio will help you form a decision of how you will eliminate your debt based on your unique situation. The chart below includes my general recommendations based on these debt-to-income ratios.

Our debts steal money from other important areas of our lives and hinder our ability to achieve a healthy financial future, which is why it is vital to create a debt elimination plan.

Now that we’ve covered the basics, let’s take a more in-depth look at the impact your debt-to-income ratio has on cash flow based on a $70,000 yearly salary or ~$4,166 monthly take-home pay. As your debt/loan amount increases, so does your monthly payment, which reduces the total amount of your take-home pay that is leftover. Obvious, I know, but using real numbers is impactful in this context.

Assumptions made:
take-home pay is $4,166/month based on tax rates in my home state (MD)
Allocation of 30% of income for housing payment
6% interest rate on loans

Let’s take this a step further and look at how this impacts a range of income levels. All three examples in the chart below have the same debt-to-income ratio of 1.0. Despite the differences in income, the percentage of income that goes towards loan payment, and leftover take-home pay is almost identical.

Debt to Income Ratio

Assumptions made:
take-home pay is $2,238 / $4,166 / $7,744 per month based on tax rates in my home state (MD)
Allocation of 30% of income for housing payment
6% interest rate on loans

As these two charts have shown, the Debt to Income Ratio is useful across wide variations of income and debt amounts.  Once you have calculated your ratio, you can incorporate your debt elimination plan into your budget. Check out my Debt Payoff Calculator to see the impact of paying extra towards your loan, paying less in interest, and becoming debt free sooner!

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